Key Points

• In any presidential election year, there are typically heightened concerns about what political uncertainty can mean for financial markets and investment portfolios. Although elections have historically affected financial markets, other factors also come increasingly into play over time, mitigating the political effect.

• Certain partisan outcomes are frequently viewed as “bad for markets,” that is, investors are more likely to face negative stock returns. However, history has shown that regardless of the party in power in the White House or Congress, stock returns have tended to deliver positive returns for investors.

• Despite the uncertainty and higher market volatility, sitting on the sidelines in cash has rarely been the better investment strategy during an election. It is time in the market, not timing the market, that matters most.

The year 2020 has already shaped up to be a year that we will never forget. On top of everything that has happened this year, it is hard to believe that in a matter of weeks, a U.S. presidential election will take place. The natural questions that often arise in an election year, particularly this year, are: 1) What will be the effect of the presidential election on stock market returns? 2) Would a Democratic sweep lead to market losses? 3) Is it a good strategy to move my portfolio to cash until the election is over?

In any presidential election year, there are typically heightened concerns about what political uncertainty can mean for financial markets and investment portfolios. It is understandable to have concerns about the election. This year, those concerns are amplified as the health, and economic impacts of the COVID-19 pandemic continue to weigh on the public.

How do elections affect the economy and stock market?

The uncertainty surrounding the election, unfortunately, could have a short-term negative impact on the economy, which is already in a fragile state of record-high unemployment, depressed business investment, and low consumer confidence.

A potential change in leadership typically means a new direction for policy. This time around, tax and spend, regulatory, healthcare, and international trade policies are front and center. Uncertainty around these important policies—in addition to other concerns about rising worldwide COVID-19 cases and escalating tensions between the U.S. and China—is likely to dampen business sentiment further and increase financial market volatility.

However, if a material downturn in the markets were to occur before or on election day (which will likely end up being much longer than a day), the volatility would probably be emotion-driven and short-lived. Stock markets have tended to power through elections regardless of whether the outcome is a divided government, party change, or an undivided government. (See Figure 1.)

Would a Democratic sweep lead to market losses?

A popular perception is that a Democratic sweep would be broadly market-negative. One policy proposal that has gained the attention of many investors is an increase in the corporate and individual tax rates as part of Joe Biden’s broader tax policy plan to raise federal revenue. A concern is that raising taxes on corporations and affluent households could halt, if not reverse, the economic and stock market recovery because higher taxes would reduce future business earnings and consumer disposable income. Fears of another “blue wave” are probably overblown for the following reasons.

A Democratic sweep does not mean the automatic implementation of major policy proposals

Presidential races tend to garner the most prominent headlines; however, congressional races play a significant role in the shaping of future policy. The makeup of the House and Senate adds a layer of uncertainty about the direction of future policy. Congress’ role in the policymaking process is why it is not always easy for newly elected presidents to fulfill their policy proposals.

While there certainly is a path for the Democrats to gain a simple majority in the Senate, it’s unlikely that the Democrats can reach a 60-seat majority. A 60-seat majority would enable it to end debates on proposed bills and prevent filibusters that could block the passage of legislation. Even in the event of a Democrat sweep, without a 60-seat majority, barriers to passing major legislation will remain—and will apply to Joe Biden’s proposal to raise taxes.

The need to support the economy will likely take priority over most other policy proposals

Next year will likely be a challenging year for the economy as it faces elevated levels of unemployment and an ongoing health crisis. This type of economic environment is not one in which higher tax rates on either the corporate or individual side is usually implemented. While Joe Biden has made tax policy a centerpiece of his campaigns, few policy experts believe that if elected, he would address tax policy right out of the gate. Biden has not suggested a firm timeline on a tax hike.

Regardless of the election’s outcome, the focus in Washington DC will likely be on enacting a more immediate coronavirus relief package to help shore up the economy. Even if Democrats were to gain control of the White House and both houses of Congress, they might delay any tax hike until 2022 (or 2023), when the economy should be on a firmer footing.

History shows that stock markets do not consistently sell-off under Democratic sweeps

It is important to recognize that historically, the stock market has not shown a consistent pattern of stock market losses when the Democrat party controls both the White House and Congress. (See Figure 2.) This historical data is not to suggest that markets will perform better under certain types of government. Still, it is useful to note that the often-cited view that Democrats may be market-negative is not historically accurate.

The fact of the matter is that the relationship between government control and stock market returns is weak, statistically speaking.² Politics and policies represent just a few of the many drivers of markets. So while U.S. presidents may have some impact on market returns, so do hundreds, if not thousands, of other factors: the actions of foreign leaders; interest rate changes; rising and falling oil prices; technological advances; natural disasters; and global pandemics, to name a few.

Is it a good strategy to move my portfolio to cash until the election is over?

It is tough to avoid negative messaging around election coverage. It is natural to become emotional and anxious when we hear all the rhetoric of political campaigns and debates. History has shown elections impact investor behavior, but it is important not to allow pessimism to steer you away from your long-term investment plan.

It may be tempting to “take chips off the table” and lower (or minimize) your portfolio risk around presidential elections. This strategy may sound logical as you could wait until any uncertainty has subsided (perhaps until after inauguration day) to reinvest into riskier investments like stocks. Unfortunately, this type of market timing is rarely a winning investment strategy, and it can significantly lower portfolio returns. (See Figure 3.)

Key take-aways for long-term investors

Today’s economic and political challenges may seem unprecedented—political gridlock, COVID-19, civil unrest, and rising tensions around the globe— but a look at past election cycles shows that controversy and uncertainty have surrounded every campaign. In each election cycle, the market has continued to be resilient over time. Over the last 94 years, there have been seven Democratic and nine Republican presidents, and the general direction of the market has almost always been up. (See Figure 4.)

Many have called the 2020 U.S. presidential election the most important in our lifetime. But that has been said about previous elections and will likely be repeated about future elections. Although this election year has been unique in countless ways, it should not lead one to abandon their investment plan. We believe the best ways to manage risk, especially political risk, is to have a diversified portfolio; to rebalance the portfolio to its target asset allocation when needed; and to stay invested at all times. These are the keys to success when it comes to investing for the long term. By maintaining a long-term focus, investors can position themselves for a brighter future regardless of the election’s outcome.

Sources

¹ https://www.lordabbett.com/en/perspectives/marketview/two-key-observations-caveat-on-2020-election.html Analysis based on data tracking inflation-adjusted S&P 500 Index price returns. Election events include both off-election and presidential elections. Divided Government is when at least one out of three of the president, Senate, and House are in the hands of one party and the other two are in the hands of the other.

² https://www.gsam.com/content/gsam/us/en/individual/market-insights/market-strategy/market-pulse/2020/market-pulse-Sep2020.html Analysis of data tracking S&P 500 Index calendar-year price returns. Returns show the median calendar-year price return for each Presidential party and corresponding Congressional party majority. Divided Congress refers to when the same party does not control the House of Representatives and Senate.

³ Analysis of data tracking S&P 500 Index (representing U.S. stocks) and US Treasury T-Bill 1 Month Index (representing cash) monthly returns. The analysis uses S&P 500 Index price returns up until 1970, and total returns thereafter. The two hypothetical investors each have $100K to invest during an election cycle and are invested in a combination of U.S. stocks Treasury bills at all times. “Fully Invested” is always fully invested in U.S. stocks. “Sitting on the Sidelines” is entirely invested in cash from around three months prior to the election (August) until after inauguration (February); and then fully invested in U.S. stocks thereafter. Returns and portfolio values are calculated monthly. Analysis starts on August 1st of each election year and reflects a four-year holding period.

⁴ Y-axis shown with logarithmic scale. Analysis of S&P 500 Index monthly total returns Dates of party control are based on inauguration dates.

Past performance does not guarantee future results. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.